The Development Impact of Small and Medium Enterprises: Lessons Learned from SEAF Investments VOLUME II: CASE STUDIES

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1 The Development Impact of Small and Medium Enterprises: Lessons Learned from SEAF Investments VOLUME II: CASE STUDIES

2 Acknowledgements SEAF gratefully acknowledges the Department for International Development of the United Kingdom, the Ford Foundation of the United States, and the State Secretariat for Economic Affairs of Switzerland, which provided grants to make the study possible. Special thanks are due to all SEAF investors who have provided resources to SEAF s funds to invest in some 210 companies worldwide. Their continuous support has enabled SEAF to carry out its commercial and developmental mission. This report has prepared by a team of staff from SEAF headquarters in Washington DC and SEAF country offices for the relevant case studies. The team consists of MinhChau Nguyen (leader), Genta Arovas, Davis Broach, Hector Cateriano, Lyubomira Buresch, Peter Righi, and Nam Pham (consultant). Professor Stephen Smith from George Washington University in Washington DC provided SEAF with the conceptual framework on facilitating and assessing the poverty alleviation impacts of SME assistance, and worked with SEAF staff on one of the field trips to Peru. The authors gratefully acknowledge the support from Bert van der Vaart and Mildred Callear who have guided the team in preparing the report. Special thanks are due also to our research team: Rachel Rochat, Sondra Albert, and Sam Sezak, and our editor: Rachel Weaving.

3 Table of Contents Artima (Supermarket Chain, Romania) 1 Fideos Coronilla (Organic and Gluten-Free Pasta and Snack Producer, Bolivia) 10 Ken-4 (Meat Processor, Bulgaria) 16 Molino (Grain Mill, Peru) 24 PPZP (Pig Farm, Poland) 30 Printop (Industrial Ink Producer, Peru) 39 Symbio (Organic Produce Distributor, Poland) 45 Tambo Inca (Flour Mill, Peru) 55 Telezimex (Electronic Components Distributor, Romania) 63 Victoria Classics (High-End Clothing Manufacturer, Peru) 70 The financial rates of return and economic rates of return for the companies profiled are based on the actual financial statements of the companies, the companies projected figures for the future years, interviews with company employees and other stakeholders, and publicly available economic and financial data. Company financial statements are the responsibility of company management. SEAF works with company management to improve the integrity of financial reporting. Select companies have annual IAS or local audits. Where audits are performed, data is adjusted as necessary to conform to audited results. In cases where the companies did not have projections, SEAF staff did their best to project the data needed for the model based on their knowledge and data availability from the past performance. SEAF and its representatives expressly disclaim any representations or warranties, expressed or implied, as to the accuracy of the future results. Past performance may not be indicative of future performance. See Volume I, Main Report, for more information on the methodology used for the case studies, as well as an analysis of the aggregate results. Prepared August 2004 by the Small Enterprise Assistance Funds, Washington, D.C.

4 Romania Artima Introduction Artima Retail Investment Company (Artima) owns and operates supermarkets in the Banat and Transylvania regions of northwestern Romania. These regions contain approximately 50 percent of Romania s total population of 22 million. Although Artima s headquarter offices are located in Timisoara, one of the primary cities in the region, its current nine supermarkets are located in secondary cities with population sizes between 50 and 200,000. These towns and cities are without many of the conveniences of the more modern cities in Romania, while Bucharest and other major cities in Romania are rapidly joining Europe s level of development. The total market for fast moving consumer goods (FMCG) in Romania is approximately 5.5 billion, with modern retailers making up only 11 percent of this market. Artima began its operations in 2001 with approximately US$ 2 million in invested capital. During the first year Mr. Banu (the main owner) and his partners opened three supermarkets, achieving 1.88 million in revenue. In 2002, the Romanian fund managed by SEAF, the Trans-Balkan Romania Fund (TBRF), invested US$ 650,000 in Artima. Artima opened three more stores. In 2003, Artima opened an additional three stores financed by the investment from the Growth Fund (also managed by SEAF), and a follow-on investment by the TBRF. To date, Artima has built nine supermarkets in the following cities: Location Pop. Date Opened Resita 93,000 Oct Lugoj 49,000 Nov Deva 76,000 Nov Sannicolaul* 38,000 Jun Caransebes* 41,000 Aug Oradea 220,000 Nov Bistrita 100,000 Jun Baie Mare 200,000 Nov Petrosani 60,000 Dec Total: 517,000 - * Includes population in nearby areas. Lugoj Supermarket All locations are considered to be at the most convenient locations in their respective towns, given their central location and the amount of foot traffic. For example, in Resita the supermarket is built in the most densely populated part of the city and in Lugoj it is built in the center of the town, and in Deva the location has been leased on the ground floor of Ulpia Commercial Center (in the very the center of the city) for 25 years. Artima has been able to obtain these premium locations with relatively attractive conditions largely due to the lack of any other significant economic activity in these cities and Artima s willingness to finance infrastructure improvements as part of its investment. Artima s investment objective is to become the first (and most strategically located) supermarket in secondary cities in the Transylvanian and Banat regions. The level of economic activity and development in these cities is generally large enough to support a supermarket with 800 square meters of selling space and approximately 5,000 stocking units (SKUs) but too small to support another supermarket. Provided 1

5 that the store locations are run efficiently, the investment thesis is that a larger international or domestic chain will ultimately purchase these locations at a good return for the Fund s investors. Development Impacts The quantified results of SEAF s development impact analysis are presented below Statistical Revenues in 2003 (US$) 18,358,746 Gross margin (%) 19 Net margin (%) - 1 No. of employees 271 % of low - skilled workers 39 Avg. wage for low - skilled (US$) 77/m SEAF investment to date (US$) 3,096,525 Realized proceed s to SEAF (US$) 106,188 Realized and unrealized (US$) 3,973,353 Multiple of capital invested 1.28 Financial & Economic Financial rate of return (%) Economic rate of return (%) Benefit/cost rat io (0% discount) Benefit/cost ratio (10% discount) 12 a 122 b 6.81 c 3.94 c a return to the company b return to society c additional dollars generated for society from every dollar invested in the company in constant terms The sections below describe the impacts on each stakeholder, which were quantified to reach the above. Private Returns The Artima investment plan calls for significant investment over four years in fixed assets as the supermarket chain establishes its potential market share growth, several years of organic growth where Artima increases its market share and operational efficiency to steadily increase cash flows, and finally a terminal value for the shareholders when the business is sold to a strategic buyer. Artima has rapidly grown from US$ 2 million in revenue in 2001 to approximately US$ 18 million in As the company grew and obtained larger buying power, gross margins have gradually increased from approximately 16 to 19 percent. Although unprofitable in the first two years of operation, Artima s increasing capital base has resulted in net cash profitability in Artima s success factors among its clientele are the location of the supermarkets, the range of products it made available, the quality of the goods on offer, and the modern retail experience that was previously non-existent. While SEAF s investments in Artima are still less than two years old, SEAF believes that the financial rate of return to its investors will be substantial. There have already been three strategic parties who have approached Artima with an interest in purchasing the company. 2

6 Impacts on Labor Artima s impact on labor is quite significant due to both the number of employees hired and the level of training they receive. As an example, each supermarket requires approximately 50 employees, 15 of which are unskilled. The remaining 35 employees are considered skilled or semi-skilled, not necessarily based on their previous job history, but due to the training and skills that are required on the job. This training is critical to Artima as the skills required for the jobs do not exist on the market. As an example, of the approximately 50 employees hired per store, about 35 are sent for one to three weeks of training at another Artima store to learn retail skills such as cashier management, product outlay and display, and inventory control. Skills necessary in the butchery and bakery departments, for example, may exist on the market, but have to be upgraded in order to comply with Artima s standards and industry best practices. Artima is therefore responsible for a significant amount of training, in addition to the simple hiring of employees. Employment Since its start up in 2001, employment in 2002 reached 568 people. Direct personnel costs were eight percent of revenue, about twice the industry average in a market where salaries are generally low. Due to the complexity of Artima s business and the need for a sizeable headquarters presence to prepare for the scaling up of the business, the first few years of operations have required a 60/40 split of skilled to unskilled employees. Due to economies of scale at headquarters, once the network is fully built out, growth of unskilled labor versus growth in skilled labor should grow at a ratio of two to one. Wages Artima s wages for its skilled labor, on average 2,100 per annum, are roughly at or near the average skilled wage in the economy, while its unskilled labor wages began above the minimum wage and are trending downwards toward equilibrium. Therefore, beyond , SEAF is not counting any direct salary contributions to the measured total development, economic or financial impact. However, because Artima, unlike many of its competitors, operates in the official economy, it pays the necessary taxes associated with employment in Romania. Black market operators which in Romania represent the bulk of the food-retailing sector avoid the taxes. A table of these taxes follows below. Personnel Taxes: Levies on the employer: 24.5% Social Insurance 3.5% Unemployment Funds 0.75% Working Book 7.0% Health Insurance 0.5% Risk Funds 36.25% Total Levies on the employee: 9.5% Social Insurance 6.5% Health Insurance 1.0% Unemployment Funds 17.0% Total Quantifiable Non-Salary Benefits Although wages for all employees are held at or near the market standard at Artima, there are a multitude of non-salary benefits paid to employees on a regular basis. These non-salary benefits are generally employed throughout Eastern Europe in order to increase the employees monthly current income without incurring even higher pension and health contribution liabilities to the government by the employee or 3

7 company. At Artima these benefits include 30 meal tickets per employee per month and at-work meals for all employees, travel allowances, apartment rent, and cash bonuses based on performance at the management level, which can equal up to three times the monthly wage. On average these benefits total an additional 1,200 per employee premium and constitute the total quantifiable non-salary input to the economic impact for purposes of the developmental impact study. 1 Artima has pioneered a performance incentive scheme, previously untried and unfamiliar in the context of the local labor market, where wages previously were never tied to performance. The structure encourages managers to focus on money-saving and money-earning aspects of store performance by sharing a portion of the savings with the manager. The scheme has the potential to be applied at the operational store level for specific tasks, although it is at present too unfamiliar to be introduced to the total labor force at Artima. The basic parameters of the scheme are as follows: Monthly Performance Measurement Store Level Value ( ) Base Salary 200 Revenue meets turnover target 50 OPEX held within 4% of turnover 200 Theft and shrinkage rates below 1% of turnover 100 Inventory revolves less than 21 days 50 Out of stock % held at target minimums 200 Total Potential Wages 800 Training Prior to their employment by Artima, skilled managers were generally either self-employed entrepreneurs or worked at the management level in a large company that was closed under privatization, while unskilled labor and skilled labor below the managerial level were previously employed in small shops or on the black market at below the minimum wage. Regardless of their background or level, each and every employee has undergone intensive training, as modern retail is virtually unknown in the cities where Artima builds its supermarkets. According to one store manager (verified by others), training is generally split into three categories: work culture, professional environment, and retail skills. Hiring decisions are based on the employee s willingness to be a productive employee and determination. Because of the work culture created under a state-controlled economy and the contraction in the Romanian economy since then, everyone goes through training on work culture and expectations, as well as how to manage working in a professional environment where productive teamwork is crucial. Training for skilled employees generally takes one to three weeks on-site at another store location, while store managers require up to three months of intensive training. Besides the elements of work culture and professional environment and other retail skills that are taught less formally on the job, skilled employees work with their counterparts at other store locations to develop the necessary skills in cash management, inventory control, the information technology system (which tracks the flow of goods from warehouse receipt to point-of-sale), and theft control. Store managers are trained in the above areas in greater depth, as well as skills in personnel management, performance measurement and tracking, and budgeting, among others. Training continues on a monthly basis to go over new procedures and/or retail trends. In addition, store managers conduct their own training programs at the store level through weekly meetings with the chiefs of each department. These costs are accounted for through the opportunity costs of the employees wages and are included in the quantified developmental impact analysis. 1 Quantifiable non-salary benefits are annualized for total employment during store expansion years and do not necessarily match fiscal year financial statements. 4

8 In 2003, Artima began a formal training program for its top managers which requires six managers to take a different MBA course at the local university at a cost of per course. About twice a week, attendees take the material that they have learned in the courses for the week and meet together with the other managers in the course and teach each other what they have learned. Mr. Banu states that teaching while learning at the same time is the best way to ensure that the managers absorb the material and is the most effective way to spread the cost of the training among as many managers as possible. Artima does not fund any manager seeking a full MBA degree, opting instead to offer individual courses to as many managers as possible. In 2003, the total cost of this hybrid formal/informal training for one academic semester was 4320, and it is expected to total 10,000 in projected years. In addition, the development impact analysis factors in a 20 percent premium on skilled employees wages as the retail skills that the employees learn are not present in the local labor market and are therefore highly prized and marketable. To date, however, Artima has lost only three upper managers, one voluntarily due to relocation to Bucharest, and two dismissed due to corruption. Consumer Surplus Artima provides a wider range of choice of products previously unavailable in the local market, and often at a higher (and more consistent) quality. Artima prices its goods at the same level as the current market, maintaining an average gross margin of percent, 2 compared to average margins of more than 25 percent in developed markets. Even when Artima s margins are lowered, such as in Oradea, store prices often remain above local market prices. This is primarily due to the prevailing level of black market competitiveness, as unregistered markets avoid the 19 percent VAT and other taxes, and, due to the cash economy, permitting smaller shops to report lower sales to authorities. It is difficult to measure the effect of quality or wider assortment of goods in an accurate and quantifiable way. It is also not clear how highly consumers currently value quality versus cost due to current household economic conditions. However, it is clear that Artima is providing local consumers with choices as to reliability of product presence and quality, range of selection, and convenience. It is also raising the standards of quality associated with food products, even if doing so may in the short run result in incremental costs to the business. For example, Artima s butchery follows all health and sanitary conditions for meat produce, including daily veterinary inspections which accordingly adds to the total cost of providing meat products. Therefore, Artima is not price competitive on meat products, as the black market does not bear these costs. Artima s meat sales are below expectations and are often a loss-producer when spoilage and price reductions are factored in. Despite what would appear to be definite contributions to consumer welfare, SEAF has not made any quantitative estimate for such factors. It is reasonable to suppose that the surplus values provided by Artima are substantial, given the significant growth in turnover per store over time. Therefore, the total quantified developmental impact for Artima is likely understated. Producers of Complimentary Goods Artima stores have impacts through at least two complementary economic agents, although more that were not captured in the study may exist. These are the security service providers, responsible for instore security at each location, and local construction companies, responsible for the construction of new stores. 2 Total gross margin averages 17 percent due to other income, such as listing and slotting fees. 5

9 Zen Security According to a regional manager, Zen Security is a security services provider with approximately 1000 employees, with a 9-10 percent market share in Northwest Romania. Its employees are generally former sportsmen who have a strong work ethic and now face limited employment opportunities. Each Artima store requires four security agents for each of the two shifts, as well as one supervisor who is usually responsible for two to three stores. Artima signed a services contract with Zen to provide overall security at each store location that is based on a fixed monthly rate, minus the cost of goods for all inventory theft above the targeted 0.74 percent. 3 Inventory theft is monitored through the difference between all goods sold according to the point-of-sale information system, minus adjustments due to spoilage, and the handcount inventory performed daily on a revolving basis throughout the month. The contribution to development impact is based on Artima s security costs, with an assumption that Zen has a 12 percent gross profit margin. An employment effect is added with the (conservative) assumption that 10 percent of Zen s operational costs are due to personnel. Local Construction Providers Artima s construction costs average about 1 million for each new store location. Of this, 50 percent are direct on-site construction costs, and another 30 percent are indirect costs that are required to renovate the location or make other infrastructure improvements that are not necessary for store operations but are required due to obligations in the concession contract with the city. The remaining 20 percent are materials and equipment that are imported. The development impact of these complementary providers is estimated at a 12 percent gross profit margin on the approximately 800,000 in total local construction costs. The employment effect is based on the assumption that 20 percent of these costs are due to labor. While not absolutely necessary, the 30 percent of construction costs that are required as part of the city concessions for the locations are often in interest of both the city and Artima. These costs may be due to road improvements, park development, and renovation of at least part of the commercial center, 4 and are further explained under the section Neighbors/Community Development. Other minimal complementary economic agents that were deemed too minimal to include in the analysis are the costs of employment advertisements in local newspapers and pick-up fees charged by local banks on cash stored on location from operations. More generally, one can see how supermarkets like Artima have important multiplier effects on the local economy. Profits of Local Suppliers Based on Artima s total inventory records, it was only possible to confirm that 1.41 percent of total store revenue is derived by local producers. This figure may be under-reported due to distributors that purchase local goods, but operate on a national scale. Total national suppliers of Romanian goods amount to about 25 percent but are not included in the development impact for conservative reasons. Local producers are generally able to maintain a 25 percent gross profit margin, though informal produce suppliers rarely include the costs of their own labor into the cost of goods. Although the quantifiable impact is minimal, Artima s introduction of bar coding into the local supply chain has had significant, if not quantifiable, effects on local producers. Previously, with informal markets and the non-existence of retail shops managing their operations though an IT system, bar coding was unknown and unnecessary to sell goods in the local market. However, Artima s IT system requires bar coding on all products. To affect this system, Artima has helped local suppliers create their own bar codes 3 Total inventory shrinkage is target at percent. The difference is due to spoilage and returns. 4 This is a multi-storied building in the centre of town that formally sold most of the commercial goods under the planned economy. 6

10 for their products. Although strictly in Artima s commercial interests, the add-on effect has been to open up the nationwide market to local suppliers who are now able to participate in large distribution networks. In addition, the IT system that Artima employs was developed in conjunction with a Romanian software company who has since employed the ERP system in other retail companies as the market grows and as retailers become more sophisticated in Romania. These undoubted benefits are not quantified in the analysis. Competition and New Entrants Despite the many positive influences Artima has on the local economy, it is also clear that Artima has a negative impact on those enterprises or individuals that were previously selling FMCG s in these cities and regions. Artima s success will therefore directly affect existing employment, especially so in the informal markets, although less so in small shops. Artima estimates that a new store takes about percent of the previous market size 5 upon entry to the city, factoring out organic market growth and the market of goods that were previously unavailable. Although no official statistics exist, the estimate is that approximately 100 employees/entrepreneurs in the black market and small shops go out of business when a new Artima store opens. 6 According to interviews with Artima employees who were formerly part of the black market employment pool, the average monthly wage was about 25, and often required 6-7 days of labor per week. Combining these factors, there is an annual negative 30,000 adverse impact per new store on employment in the local economy. As our study of the effect on employment concentrates on the economically inactive versus the unemployed, official statistics are unlikely to support these assumptions. Our analysis is based on assumptions that were derived from interviews with Artima management and staff. The effect on local unofficial employment must also be counterbalanced with the official employment created by the new store. A new store is the largest commercial business in some of the smaller towns, with roughly 50 employees per store and revenues between 1-3 million per store. Based on Artima estimates derived from employment interviews, almost all of their employees at the store level either previously worked unofficially in the same sector, or were economically inactive. With official employment, not only is the minimum salary almost three times their wages earned in the unofficial economy, but employees also join the national health and pension system and receive the other non-salary benefits. Furthermore, Artima only requires that the employees work five days a week. This factor offsets the original negative impact on employment. As previously mentioned, Artima also pays 19 percent VAT and other corporate taxes and fees on the market share they replace. Neighbors/Community Development Artima makes many infrastructure improvements to the cities as part of its concession agreements. In almost every city where Artima has developed a new location, some type of civic concession has been part of the agreement. A table follows below: Store Location (City) Resita Lugoj Deva Sannicolau Carensebes Oradea Civic Improvement per Concession Agreement Refurbishment of central park: e.g., paths and lighting. Expansion of parking facilities in downtown area. Rent. Some renovation to Commercial Center. Minor improvements to main road and main intersection. Rent. Major renovation of bottom floor in Commercial Center. Shared 1/3 of the costs of new park in formally abandoned land space, construction of playground. 5 This figure is a range of the total market share estimated with the black market and official figures. 6 Though registered, small shops are included in this analysis as most employment in the shop is unofficial. 7

11 Bistrita Baia Mare Petrosani Minor infrastructure repairs. Development of abandoned land space, new parking near bus station. Development of abandoned land space for commercial activities, and enhanced traffic patterns. In many cases, whether Artima takes over abandoned land or underdeveloped commercial space, improvements in the land area around the store location improve traffic flow (car and foot) and increase the visibility of the location. For example, the park developed in Oradea around the store was formerly an abandoned pit between high-rise housing developments. This area, which was bypassed by traffic between the surrounding high-rise housing, has been transformed into a large green space and playground that not only enhances the quality of life of nearby residents, but is a gathering and crossing point for residential traffic, which improves store revenue. Improvements to commercial centers revitalize a formerly popular commercial area in the center of the city, which in turn re-energizes the city center. Although not completely commercially necessary for the development of new stores, Artima is willing to absorb these extra costs as part of the agreement for a multi-year concession since these costs improve traffic flow and visibility of the location. These non-quantifiable benefits that the Artima investment brings to the community, including the improved quality of life factor due to infrastructure improvements in the center of the city, increased assortment, and higher quality goods, are not included in the development impact tallies. Other Social Benefits The main other social benefit from Artima s business is the financial contribution to the government and local financial institutions. As detailed in the model, Artima s contribution to the government comes less from profit taxes (for the first few years, Artima has a tax credit due to its losses), but through other contributions such as unreclaimed Value Added Taxes, import taxes, other corporate taxes, contributions to the National Pension Fund, and other social taxes, including excise taxes. While these contributions may be taken for granted in developed economies, Romania only recently was granted the status of a market economy by the US government, and still has not passed the hurdles for the same designation from the European Union. In addition, the government must undertake significant fiscal reform in order to qualify for eventual EU membership. Artima, by replacing the market share of non-tax paying businesses, thus makes substantial contributions to the normalization of Romania s fiscal budget one city at a time. There are also benefits such as financial institutions profits made from loans to Artima, but due to the lack of data, these benefits are not included. One Store s Story: Resita With a population of about 93,000, Resita is the capital of Caras-Severin county (highlighted in the map to the right), located in the southwest region of Banat. Official unemployment in the province is 9.7 percent, higher than the regional average of 8.6 percent and the national average of 8.3 percent. It is difficult to estimate the true status of unemployment due to the dropping out of those who are no longer actively searching, but approximately 40 percent of the population is employed. This is largely due to the closing of many businesses in the iron and steel sector due to the restructuring of the economy and privatization. Resita was the first of the Artima stores to be built with the invested capital of the entrepreneur, Mr. Banu, as well as the know-how value received from an Austrian colleague who is a director of another supermarket chain in Eastern Europe. Although unemployment is high, several factors influenced the decision to build the store in Resita: the location that city authorities offered Artima was in the center of the city, the immediate catchment area is the densest of the city and, in Artima s judgment, could support 8

12 a supermarket, and the relatively high percentage of disposable income which the poor in Romania expend on FMCG. These factors have generally been used in evaluating all other locations for Artima. Resita Supermarket As part of the purchase agreement for the land, Artima promised the city that it would repave the paths in the central park and install lighting, which was intended to revitalize the city center and improve night-time safety. Artima was willing to undertake this investment because it was likely to increase traffic flow to the store. Although it is impossible to measure the effect of the improvement in sales without a test case, the store became profitable in the second full year of its operation In a relatively small city, the improvements undertaken and the new supermarket generated much publicity and interest. On opening day, the entrepreneur and his management team were unprepared for the reception they received. While the official opening with city officials and speeches was coming to an end in order to make way for the grand opening to the public, a large percentage of the city population had swarmed against the glass windows and doors to get in. Although there were no problems other than some theft due to security guards inability to see past the large number of people in the aisles, the managers were afraid that they would need help in crowd control when they first saw the public s reception. The only retail experience of most of the population had been in poorly lit shops with limited selection, or in outdoor markets. The display, assortment, and even the shelving and cooling equipment were curiosities, which generated large traffic. Since then, Artima has worked to distribute flyers with promotional pricing which has gone some way toward improving sales. It is estimated that Artima has a 30 percent market share (perhaps 15 percent with the black market factored in), but makes up 80 percent of the market for all food stamps. Resita employs 44 people in the city (not including eight Zen security guards), 23 of which are skilled and 21 unskilled. The workforce, including at the corporate level, is relatively young, between 19 and 50 years old, and is predominately female, with 9 male and 35 female employees. The first two store managers in Resita s history have been promoted internally in Artima and now work at the corporate level. The current store manager, O., was previously selfemployed, and has some financial and investment background which has proven useful given the financial analysis performed at the store level to ensure that targets are met. O. stated that the competition for a job at Artima is very high with multitudes of applications per open position, but that hiring is actually very difficult at the skilled and unskilled levels due to the lack of a working culture among most of the applicants. Compared to many other businesses active in the region, Artima is seen as a large company that provides a sense of stability to employment. All the employees we spoke with state that the benefits of working in the official economy was the main reason they sought employment at Artima, with the assumption that it would also be at a higher salary, though in one case an employee did not know the size of her monthly wage until she received her first wage. The skills they have learned range from customer service, teamwork, to certain aspects of performance reporting that are then aggregated at the end of the month at the store and corporate level. 9

13 Bolivia Fideos Coronilla Introduction Fideos Coronilla S.A. (Fideos) is located in Cochabamba, Bolivia. The company produces highly nutritious certified organic and gluten-free pasta and snack products using Andean grains mainly for export markets. Bolivia, long one of the least developed Latin American countries, made considerable progress in the 1990s toward the development of a market-oriented economy. Successes under President Sanchez de Lozada ( ) included the signing of a free trade agreement with Mexico and becoming an associate member of the Southern Cone Common Market (Mercosur), as well as the privatization of the state airline, telephone, railroad, electric power, and oil company. The country also found rich reserves of natural gas ready for export. However, due in large part to the current political turmoil, Bolivia has not realized the potential latent in these achievements, and today, more than 60 percent of Bolivians live in poverty. Moreover, there is a high level of poverty inequality between the urban area (poverty rate of percent) and the rural area (83.41 percent). 1 The average adult gets only 7.7 years of schooling, and Bolivia has the highest infant mortality rate (58.4 deaths per 1000 births) in the region. The official national unemployment rate 2 is 8.69 percent in 2002, but this figure is misleading, as the level of underemployment is extremely high. Mr. Guillermo Wille founded Fideos Coronilla in 1972 to produce high-quality pasta for the Bolivian market. The company grew rapidly over the next fifteen years, tripling its production capacity. Since then, competition (especially from small, informal producers that do not pay taxes and social security payments) has increased significantly for wheat pastas, squeezing margins and leaving the relatively small plant unviable in this area. The company changed course in 1995 and began its research and development activities. Under the direction of Ms. Marta Eugenia Wille, the founder s daughter, Fideos has developed its own methods of crystallizing gluten-free pastas and popping snacks. Fideos manufactures gluten-free products that are suitable for people who suffer from Celiac Disease, a serious allergy to the protein part of wheat, rye, barley, oats and related grains. People suffering from this disease can damage their small intestines if they consume gluten. Most pasta and snacks contain gluten. Therefore, Fideos s products have a market niche, including Celiacs and other diet-conscious consumers, such as diabetes. 1 The World Bank Technical Annex for a Development Credit for the Proposed Emergency Economic Recovery Project to the Republic of Bolivia Report T7611 BO, December 8, ILO Statistics on Employment Online Data for

14 In early 2002, Fideos received a capital investment from SEAF s Fondo Capital Activo de Bolivia (FCAB), an investment fund that supports small and medium-sized Bolivian businesses with high growth potential. Marta Wille and Fideos other shareholders all direct family members of the founder chose to work with SEAF because they felt that the participation of an international institutional investor would increase the professionalism and business prospects of the family-run business. Aside from the attraction of receiving capital, the original shareholders also saw the opportunities offered by SEAF s Business Development Unit (BDU), a sales and marketing group operating in Europe and the United States, to help market Fideos s brand and expand its markets. Since SEAF s involvement, accounting procedures have been dramatically improved and the company has achieved the transformation to a stock corporation. Following a SEAF analysis, the company discontinued the production of lossmaking pasta lines for the local market and focused instead on producing for export markets. SEAF s BDU assisted the company in improving its export sales strategy and entering the US market, while Fideos concentrated on an increase in local sales of selected lines of organic snacks. SEAF s BDU also helped Fideos in repackaging and branding its products, an important component of its foray into various niche markets in the United States. Working through a US broker, SEAF has introduced the products also to more than 150 stores specializing in organic sales in the United States. Fideos organic pasta and snack products Export to one of the stores in Maryland, USA SEAF invested US$ 410,000 in Fideos to finance its working capital requirements, strengthen its administrative procedures, develop a marketing plan, and finance capital expenditures to improve its production process. SEAF also helped Fideos to obtain financing of about US$ 350,000 from Cordaid, a non-profit organization from the Netherlands. 11

15 Development Impacts The quantified results of SEAF s development impact analysis are presented below Statistical Data Revenues in 2003 (US$) 367,193 Gross margin (%) 37 Net margin (%) -26 No. of employees 29 % of low-skilled workers 64 Avg. wage for low-skilled (US$) 85/m SEAF investment to date (US$) 410,000 Realized proceeds to SEAF (US$) 42,880 Realized and Unrealized (US$) 350,379 Multiple of capital invested 0.85 Financial & Economic Benefits Financial rate of return (%) Economic rate of return (%) Benefit/cost ratio (0% discount) Benefit/cost ratio (10% discount) 21 a 51 b c 5.32 c a return to the company b return to society c additional dollars generated for society from every dollar invested in the company in constant terms The sections below describe the impacts on each stakeholder, which were quantified to reach the above. Private Returns Fideos had a difficult time while switching from producing loss-making conventional pastas to produce organic products. After an initial decline in total sales, Fideos s revenues are estimated to increase by 25 percent from before SEAF invested in the company, and the gross margin went from about 5 percent in 2001 to about 37 percent in However the real benefits of the investment are expected to come in the next few years as the company increases its exports to Europe and the United States. Sales of natural and organic foods and beverages are growing worldwide at more than 12 percent, outpacing sales of conventional grocery products by more than 4 to 1. Organic products are experiencing natural growth while headline issues such as trans-fatty acids and the so-called obesity epidemic have challenged consumer confidence in mainstream goods. Conventional food, drug and mass merchandise retailers now account for more than 75 percent of natural products sales, with these mainstream retailers aggressively adding natural products to their shelves in order to capture some of the rapid growth the industry has enjoyed for more than two decades. However, the natural supermarket channel is still the destination spot for consumers and manufacturers alike. The average sales per store in a natural products supermarket outpaced that seen in a conventional supermarket by as much as 20 to 1 across categories and brands. SEAF s BDU has assisted Fideos in developing and implementing a market entry strategy for its branded products in The BDU worked with Fideos s clients and designers to develop appropriate packaging 3 The 2003 estimates are annualized based on actual results for the first three quarters. 12

16 and advertising materials. In addition BDU located and brought on board a US distributor Health Flavors from Brewster, NY to carry Fideos s products in natural food stores on the East Coast of the United States. The BDU has started an aggressive marketing plan to drive distributors initial sales via the Celiac community who are the niche consumers for Fideos s products. The company expects to reach the million-dollar mark by 2005, as increased marketing increases the demand for the product and the unit costs in the production of goods continue to decrease. The financial rate of return is projected at 21 percent over a ten-year period. Impact on Workers Wages and Benefits Fideos has a high proportion of low-skilled workers (64 percent of total employees), 95 percent of which are female. Low-skilled workers at Fideos receive a wage higher then the minimum wage in Bolivia. The minimum wage in Bolivia was approximately BS 430 per month (US$ 70) in 2003, whereas the worker earning the lowest monthly wage at the company received BS 500 (US$ 71). Most low-skilled workers at Fideos earn about BS 600 (US$ 85) per month. High-skilled workers are mainly managers and administrative staff. Fideos had to lay off about 12 workers in 2002 as the production of conventional pasta was terminated, which was a very difficult decision for the owner as most workers have been with the company from the beginning. In addition to salary, workers receive significant benefits. Workers with children under the age of one receive milk subsidies at a cost to the company of about US$ 1,500 a year per employee. The long-term benefit of proper nutrition during the first year of life has a substantial impact on the health and welfare of children. The company also invites a medical student from a nearby hospital several times a year to speak to the workers about symptoms and prevention of various diseases. Workers are given vaccinations and pregnant women receive pre-natal education. As a result of this medical education program, the number of workers who miss work because of illnesses has decreased. Fideos also contributes to social security and state health benefits for its workers. Increased wages and healthcare have made workers at Fideos healthier than the average Bolivian and have increased the chances for their children to lead healthier and more productive lives. Training Fideos s owner, Marta Eugene Wille is very dedicated to the welfare of her employees. The company is a family business, and the employees feel like they are part of the family. One of the areas that distinguish the company from others is the owner s dedication to improving the employees skills. She identifies good workers with a propensity to learn and helps them to further their formal education. This approach has resulted in her ability to retain good employees most of the employees have been with the company for 8-10 years. Fideos, together with a number of other SMEs in Cochabamba, contributes about one percent of its total payroll to a local organization called INFOCAL. INFOCAL offers technical training, including mechanical training, which is a very important part of Fideos s production process. Some workers are also trained by IDEA and FUNDES, business support services in the region, which require Fideos to make a payment for their services. On average, Fideos has spent about US$ 3,600 per year on training its workforce, or about one percent of its gross sales in

17 Training and Caring for Employees The Story of FIDEOS The owner s (Marta) commitment to her employees is demonstrated through an experience of one of the women who works at the company. This woman came to Fideos with no skills and got a job bagging finished products. Marta and her production manager started noticing that this worker was very interested in mechanics and was able to do some minor repair work on the machines. She encouraged the woman to enroll in a two-year technical engineer course and paid for her education. Now, this employee is earning a much higher wage and is able to educate her children. Marta is also very strict about quality and standards, which is extremely important in the food industry. Marta trains her employees in food hygiene regularly. In addition, she organizes weekly meetings on Saturdays to educate workers on various topics related to health and hygiene. Marta is also committed to investing in the human capital development of her workers families. She gives out yearly awards to her workers children to motivate them to excel in school. For the past two years she was proud to present the award to the daughter of an illiterate worker. Marta and the company strongly believe that when you educate a woman, you educate a nation, and she therefore dedicates a considerable amount of time and resources toward educating employees and promoting the education of her employees children. Impact on Suppliers Fideos s basic raw material inputs (wheat, rice, quinoa, and cañawa) are produced in Bolivia by associations of low-income small farmers. Fideos purchases quinoa, a traditional Andean grain, from local cooperatives, benefiting about 6,800 farmers. Through these cooperatives, farmers receive 90 percent of the sales price, with the remaining ten percent reserved by the cooperative for administrative and marketing costs. Fideos also uses cañawa, a rare Andean grain that is grown only in a remote and isolated area. Prior to Fideos purchases, the grain was produced mainly for local consumption. To purchase the products, the company s representatives have to travel two hours by foot and donkey to reach the area. Currently, the amount purchased is relatively small, about two tons, but these purchases benefit at least 30 families. With export market expansion and the benefits of branding, however, it is expected that Fideos will be able to increase its purchases and help improve the living standards of even more of the poorest of the poor in Bolivia. Fideos Helping poor farmers to export quinoa and cañawa Fideos is a certified organic producer. Apart from products containing cañawa, which is not currently available grown organically, Fideos maintains organic certification for all its export products through Imo Control, a Swiss certifying organization. This certification requires strict quality control and the exclusive use of certified organic raw material in organic products. The certification also demands that the production facility produce no toxic residuals. In addition, Fideos is guided by HACCP (Hazard Analysis and Critical Control Point) norms. The owner has had to import organic rice as she is not able to purchase the product locally. However, she would like to be able to work with farmers to certify local rice production should grants be made available. 14

18 Impact on Consumers Fideos s products are virtually all exported and therefore we do not include the benefits to consumers in the analysis. Fideos began to experiment with selling organic snacks to school programs. However, this is relatively insignificant at this stage and therefore we do not take the benefits into account in the development tallies. Impact on Competitors and New Entrants Fideos does not currently face local competition although international competition is significant. The main challenge for Bolivian producers is the penetration of export markets, which is out of reach for many smaller producers without assistance from an international partner such as SEAF. The success of Fideos in selling organic snacks in domestic markets might encourage new entrants. However, benefits for these stakeholders are not included in the analysis. Impact on the Rest of Society Environment: IMO certification demands that a production facility have no toxic residuals. In accordance with this standard, Fideos does not have any residuals other than water to clean equipment and five percent of the raw materials that are sold as animal feed to local farmers. Community development: Fideos provided resources to the local training facility INFOCAL (see page 13) which benefits her employees as well as other SMEs employees. Through various health training programs, Fideos has contributed to the employees welfare to a point beyond that needed to maintain a high standard for a food production company. Finally, the attention on health and education of her employees children has a longer lasting effect on poverty reduction. Local taxes: Fideos paid approximately 28 percent of total revenues in various taxes. This is significant for a small company that has not made much profit for the last three years. 15

19 Bulgaria Ken-4 Introduction Ken-4, AD (Ken) is located in the lush countryside in central Bulgaria. Stara Zagora is a town of about 150,000 inhabitants, about 225 kilometers from the capital city of Sofia. In 2001, the average GDP per head of US$ 1,434 for the region of Stara Zagora was about US$ 300 less than the national average of US$ 1,718. The unemployment rate for the region is approximately 17 percent. Rumen Nonov, an engineer by training, established Ken, a meat processing facility, in 1992 and became its General Manager. Two friends, Rumen Kuzmanov, the Production Manager, and Plamen Isionov, the new company s Sales Manager, joined Mr. Nonov. Mr. Kuzmanov is a trained veterinarian who had worked for a number of years as a veterinary inspector at a local pig farm and was the only one of the principals with some knowledge of meat processing. While Mr. Isionov had little practical experience at the time, he had traveled extensively internationally and had an engaging personality that helped to build good relations with clients and suppliers. Ken was established in Stara Zagora and began operations in the early 1990s and grew rapidly with the infusion of capital from SEAF and the provision of technical assistance to develop its marketing and sales strategies. The company approached SEAF in 1995, when the entrepreneurs realized that they needed long-term capital to finance their bold business plan for the construction of a new sausage manufacturing facility to replace what they had built around a trailer and a shed. SEAF agreed to purchase 49 percent of the company shares for US$ 125,775, and additionally provided a loan of US$ 175,000. The objective of this investment was to acquire land, construct a new facility, and purchase additional processing equipment. The facility would allow the company to double its production capacity. Despite the clear plan, Ken experienced unforeseen difficulties in 1996 when Bulgaria entered into a period of severe political crisis and economic decline (GDP plummeted almost 10 percent in 1996 alone), hyper inflation, dramatic currency devaluations (the exchange rate went from 14 leva to the US dollar to 2300 leva to the US dollar over a two-year period), and a banking crisis that resulted in many bank liquidations. During this period, Ken focused on staying on top of its market and its finances. As a result, Ken did not build the new plant as planned. These many setbacks had to be financed with more loans and equity from SEAF. In July 1999, after its third round of financing, SEAF had invested almost US$ 600,000 in both equity and debt. Twelve months later, in June 2000, the processing plant was completed with a total of 2,800 square meters and a capacity to produce 12 tons of sausages and other processed meat products per day. In addition to providing the critically needed capital, SEAF provided technical assistance. SEAF arranged a visit from a marketing consultant from the Canadian volunteer executive organization to advise the company on its marketing and distribution strategy. SEAF provided a company with extensive help with its accounting and reporting systems. SEAF also arranged a visit by a German expert in meat processing 16

20 and machinery to consult the company on organizing the production more efficiently, installing the necessary machines and equipment, and implementing better controls of materials and inventory. In March of 2001, SEAF exited from its investment in Ken, selling its shares and debt to the management for a total of US$ 1,113,759, which is almost twice the amount invested. This generated a financial rate of return of 26 percent, a commendable result given the economic conditions during most of SEAF s investment period. As a testament to the strong relationship SEAF built with the company, the entrepreneurs provided SEAF with extensive data, even two years after the exit, for this case study. The rest of the case study focuses on the various development impacts of Ken, including a brief examination of the effect of Ken s existence and business activities on poverty alleviation in Stara Zagora, Bulgaria. Development Impacts The quantified results of SEAF s development impact analysis are presented below Statistical Data Revenues in 2003 (US$) 5,952,381 Gross margin (%) 25.6 Net margin (%) 14 No. of employees 125 % of low-skilled workers 88 Avg. wage for low-skilled (US$) 105/m SEAF investment to date (US$) 594,299 Realized proceeds to SEAF (US$) 1,113,759 Realized and unrealized (US$) 1,113,759 Multiple of capital invested 1.87 Financial & Economic Benefits Financial rate of return (%) Economic rate of return (%) Benefit/cost ratio (0% discount) Benefit/cost ratio (10% discount) 26 a 37 b 16 c 5.94 c a Return to the company b return to society c additional dollars generated for society from every dollar invested in the company in constant terms The sections below describe the impacts on each stakeholder, which were quantified to reach the above. Private Returns The project has been successful in terms of both private and broader economic returns. Ken has survived a severe economic crisis and has become a profitable small venture. Since late 1995, when SEAF became its partner, the company s capacity has increased almost tenfold. The company is the leader in Stara Zagora in modernization of production facilities for sausages. Before Ken was established, sausages were produced either in the big and inefficient (and unprofitable) stateowned meat processing enterprises, or in the basements of individual micro-entrepreneurs. In both cases, either the quality of the product or its price, or even both, were compromised. Due to the new capital and 17

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